Volume XXVI No. 10/11, 2013 Environmental Business International Inc.REPRINT - Consulting & Engineering 2013

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DEATH OF MID-SIZE FIRM IMMINENT? NEW DATA SAYS “NOT SO FAST”

For a number of years now, many observers of the environmental consulting and engineering indus-

try, and the architectural and engineering industry generally, have suggested that the mid-size firm is on a course towards ex-tinction. Pressed from above by more re-source-rich large firms and from below by more nimble and locally connected small firms, the mid-size companies supposedly face the choice of growing, selling out to a larger firm, or perishing.

A mid-size firm, by this account, has as much chance for long-term survival as the great auk. Evolve out of the mid-size cat-egory, or die.

Not every industry analyst or profes-sional subscribes to this view. The mid-size firm, however you define it—$15 million or $20 million to $100 million or more in revenue—never seems to go away. More-over, a good number of firms within this approximate revenue range are thriving even as they resist the urge to sell, and they insist on maintaining control of their own destinies. In any case, real data determin-ing whether mid-size firms are poised for demise or can thrive as mid-size firms was lacking.

Until now. An ongoing study by a team of academics and industry veterans is gen-erating findings indicating that mid-size firms have staying power. How they’re do-ing it will be the focus of the next phase of the study, but for now, the data indicates that mid-size firms can persist with a resil-ience that may come as a surprise to some industry analysts.

Industry veterans Gerry Salontai and Rod Hoffman, now respectively with the strategic planning, business management, and leadership development consultancies

Salontai Consulting Group, LLC (Ran-cho Santa Fe, CA) and S&H Consulting LLC (Evergreen, CO), jest about whose idea it originally was to peel back the on-ion and look in depth at the “demise of the mid-size firm” hypothesis. Both, however, had long suspected that the hypothesis was lacking in support, and they decided joint-ly that it was ripe for analysis.

“Those firms that establish and maintain very deep relationships with clients persevere in the ups and

downs of economics cycles.”

Salontai, formerly head of architectural and engineering (A/E) firm Kleinfelder (San Diego, CA), and Hoffman, national director for strategic planning and acquisi-tions for many years at multidisciplinary engineering firm HDR Inc. (Omaha, NE) until about 2008, formed a collaboration with Jeff Holcomb, chief development officer at Larson Engineering (St. Paul, MN), and Colvin Matheson of Matheson Financial Advisors (McLean, VA) to as-sess the place of mid-size firms in the A/E industry. As a key first step, they engaged University of Colorado engineering profes-sor Paul Chinowsky to, as Matheson puts it, “slice and dice the numbers” from Engi-neering News-Record’s (ENR) Top 500 De-sign Firms lists going back to the 1970s.

Looking back that far would pull in a full series of economic cycles, including the 1980-82 recession, which at the time “was the biggest since the Great Depres-sion,” Matheson tells EBJ. Although the lists reported revenue by groups rather

than individual companies prior to 1986, and although the reporting segments have changed over time (e.g., the Top 500 no longer breaks out hazardous materials, even though the ENR Top 200 Environmental Firms lists do), the study period provides a solid basis to evaluate company perfor-mance through economic cycles, including the latest one, which was “the deepest re-cession in 80 years,” says Matheson.

The analysis broke the company popu-lation into peer groups, with the “mega-firms” constituting the top 10 by revenue, the very large consisting of numbers 11 through 30 on the lists, the large check-ing in at ranks 31 through 100, and the medium-size firms constituting ranks 101 through 500. The number 100 firm on any given list “had about $100 million to $115 million in revenue,” says Matheson.

MID-SIZE FIRMS GAIN GROUND

A key finding in the “slicing and dic-ing” of the data for these peer groups was the following: firms with revenue ranging from $17 million to $113 million main-tained or increased their numbers and their market shares in several key sectors over the years, while constituting just 7% of the total industry. In addition, the research team found that the number of mid-size firms in transportation remained constant, while those in the general building sector increased over the years by 11.6%.

These data do beg a question however: Do they show that mid-size firms are more resilient than some have suspected, or do they simply show that there is a life cycle for A/E firms—growth from small to mid-size and then either continued growth to “large,” or acquisition by larger firms, or failure, with a constant stream of compa-nies moving through the pipeline?

“It’s a little of both,” says Salontai. “There are some firms that have gone through the cycle from small to medium

2 Strategic Information for a Changing Industry

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EDITORIAL ADVISORY BOARDAndrew Paterson, Chairman; Dr. Edgar Berkey, Vice President, Concurrent Technologies; Richard Fortuna, President; Strategic Environmental Analysis; Daniel Noble, Founder, Resource Trends; Paul Zofnass, President, Environmental Financial Consulting Group

to large and very large. They’ve done that quite successfully and done it by design, putting together a strategy that allowed them to do so.”

Other companies have gone through portions of the cycle and “ultimately sold the business,” Salontai continues. “And there are others that have stayed in the mid-size firm category.” These firms have “maintained their ownership structure and not sold the company, because it’s their stated goal not to do that. They’ve em-braced a philosophy that says, ‘we’re going to stay privately held, control our destiny, and grow at a respectable rate,’ and they’ve succeeded in doing so. They want to create a ‘generational-type’ company.”

There are many firms—some clients of Salontai’s—that “are very committed to their ownership structure.” They cite that strong desire to control their own destiny and to foster a collaborative culture that facilitates professional development as the primary reasons for that commitment. If there were a third reason, it would be an ability to retain competitive advantage and provide more attention to the client, Sa-lontai observes.

RESILIENCE OVER TIMEHoffman goes back to the study data

to underscore the view that mid-size firms are, indeed, demonstrating resilience. Over the 35-year study period, he points out, about 1,550 firms were listed on the ENR 500 at one time or another. Of these,

61 firms have been listed every year—not necessarily increasing in rankings, but at least remaining on the list—and of those, 31 were what the study team classified as mid-size firms.

Taking a deeper look, the team found that, of the 61, 37 firms actually did in-crease their rankings over time, and of those, 18 companies were mid-size firms.

“Then it gets really interesting,” Hoff-man tells EBJ. Of the 37 firms that stayed listed through the study period and in-creased their rankings, 17 out-performed their peer groups. Of those 17 firms, 10 were mid-size companies. “These guys aren’t going away. They are performing quite well.”

There were other findings that pre-sented some surprise, not just about mid-size firms but about the nature of the A/E industry generally, Hoffman points out. Most tellingly, while many analysts have tended to regard the ENR 500 as very rep-resentative of the industry, that population of companies actually accounts for only one-third of total industry volume.

“Two-thirds of the revenue generated is coming from firms not on the ENR 500,” he notes. The total universe encompasses about 115,000 firms, so “it’s a smaller-firm industry.”

M&A TARGETS ARE SMALLWhich makes sense of some of the

historic data around mergers and acquisi-tions (M&A) in the industry, he hastens to point out. “One question we asked was, are the mid-size firms the ones primarily being targeted in acquisitions,” says Hoff-man. “We didn’t find that. In fact, there seems to be evidence that the smaller firms are the ones being targeted.”

The smaller pickups align with a shift in M&A strategy from acquiring companies in the same market sectors to acquiring firms that bring some diversification to the table, Hoffman explains. The majority of deals during the period from about 1985 to 1995 were additions of firms that could strengthen existing market positions—in general building, or energy and power, or water and wastewater, for example—but since then, deals have increasingly been

M&A Activity and Market Consolidation in ENR Top 500

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3Strategic Information for a Changing Industry

used to implement a diversification strat-egy rather than simply build on historic strength.

“By 2005, the ratio is about two to one,” says Hoffman. “That’s very clear in the data. There’s been a big transformation in M&A, from strengthening the basic firm to market diversification.”

The notion that mid-size A/E firms live an imperiled existence derives at least in part from the idea that they face some special pressures. There’s some truth to this idea, the research team acknowledges.

“What we generally hear from mid-sized firms is that they feel squeezed from the top and the bottom,” says Matheson. “Big firms drift down into their markets or territory, selling strong project resumes and portfolios, with very skilled talent to put in their marketing packages. They may have some cost advantages based on size, but generally may be more willing to ‘buy’ the work with low fees just to cover their overheads and keep their personnel busy until the economy and marketplace finally finds its footing.”

Clients may now be more aware of this “bait and switch” tactic, “and that bodes well for the mid-sized firms who rely on re-lationships and direct contact with princi-pals and the firm talent,” Matheson notes. Meanwhile, “the pressure from small firms comes from their very low overhead struc-tures—for a different reason—and from the fact that they simply charge lower rates and claim they can do the work.”

PRESSURE? DEAL WITH ITTo mid-size firms that complain about

these pressures, “my response is, ‘so what? Everyone has competition. Deal with it,’” says Matheson. “That is the reality, so you better know what it is you are selling and what your buyer is buying, so you can build the case as to why they should hire you. Maybe it is best to let low-price jobs go to others,” he notes, acknowledging that some firms are not so disciplined.

Ultimately, “we hear the same things from small firms, large firms, and very large firms,” Matheson remarks. “And my guess is that it does not matter what indus-

try you are in either; they all seem compet-itive. There are good clients and there are not-so-good clients, and most of us want to spend our time with clients that value what we do. If they value the marginal difference in fee structures that firms may have, then that tells you something about working with them and the market you are serving.” Salontai and Hoffman agree with these points. Salontai adds that to focus on whether the pressures facing mid-size firms are unique or special in any way is to get caught up in distractions. “Obviously there are different pressures with all types of firms. The question is not whether they are special—it’s whether they are impor-tant.”

“Obviously there are different pressures with all types of firms. The question is not

whether they are special—it’s whether they are important.”

Hoffman suggests that firms, regardless of their size, that do not feel threatened by others “are staying true to their busi-ness model, be it operational excellence (low cost), customer intimacy (client ser-vice), or product excellence (innovation).” What causes stress “and the feeling of be-ing squeezed is drifting from your business

model—trying to play in two, or even three,” he stresses. The old adage, ‘you cannot be all things to all people,’ applies here.”

These responses speak to the question of how the mid-size firms that are thriving are doing so. The “how” and the “why” are the focus of the next phase of the research. The research team is looking to take a Jim Collins approach (author of Good to Great and Great by Choice) to determine defini-tively why some firms have not survived while others have prospered. “We want to go back and look at the data and then ac-tually talk to the leaders of some of these companies,” notes Hoffman.

Drawing upon his experience, Salontai offers some thoughts on where to look for the answers to the “why and how” ques-tions. “I definitely believe there are a few differentiators” in the mid-size firms that succeed. “A client focus is clearly a dif-ferentiator. Those firms that establish and maintain very deep relationships with cli-ents persevere in the ups and downs of eco-nomics cycles.”

Providing good service—as every firm claims to do—is part of it, but that doesn’t get to the real differentiator. “Firms that are really client-focused make it a mandate to thoroughly understand their clients’ busi-ness as well as bring clients into theirs—not only to speak but also to participate in forward-looking workshops,” says Salontai.

Different Size Firms Dominate Different Market Segments

� Strategic Information for a Changing Industry

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Such firms also have programs in which “the top executive reaches out to the top clients every year. Throughout their orga-nization, they are all over the clients—and that can translate into relationships that differentiate.”

DON’T BURDEN STAFF WITH RED TAPE

The internal side of that differentiator is having the right people on board, and “getting them into the right seats and giv-ing them the right tools,” he explains. Not that there’s anything wrong with provid-ing your staff with top-tier benefits, but in Salontai’s view, a key differentiator is keep-ing the bureaucracy, red tape, and other obstacles from getting in between the pro-fessionals on staff and the clients.

Both of these differentiators speaking to something deeper—business funda-mentals. “I think there are too many firms in this business that run their firms as life-style businesses,” Salontai says, pointing out that “life style business” can refer to different things, from country club mem-berships for staff or sending professionals out to lots of conferences, to emphasizing ownership interests. “A shareholder-value or business-fundamentals company is one that focuses on making money and instills that value in its people at every level, be-cause it knows the firm can be more com-petitive and stand the test of time.”

Pointing to work by management con-sultancy McKinsey, Hoffman notes other differentiators in the successful mid-size firms. They plot a course towards several horizons on the path to growth, and accu-mulating capital through solid profitability is critical to reaching Horizon 1.

“Firms that are profitable have stronger balance sheets, they have capital, and they aren’t draining the swamp every year by, say, giving it all out in bonuses.” Horizon 2 involves being nimble—acting “ahead of the market” by keeping track of the trends—and deploying the accumulated capital to move with those trends and take advantage of the opportunities.” Horizon 3 “is way down the road,” towards a long-term strategy, Hoffman notes.

The data thus suggest that mid-size firms appear to be here to stay, and who knows—perhaps the recent recession honed their ability to thrive. “Over the last few years of economic downturn, firms have learned to do more with less,” says Matheson. “I think the resulting sharpen-ing of business practices will actually auger well for mid-sized firms that have survived this long period of economic malaise and uncertainty. When the markets finally do begin to show more certain and sustained growth, I would watch out for the mid-sized and large firms out there. I think the very large and mega-firms are going to be the ones squeezed!”

Excerpted from the Consulting and Engineering 2013 edition of EBJ and reprinted with permission from Environ-mental Business International Inc. All rights reserved.© 2013 EBI Inc., www.ebionline.org